Ahsan Habib: Economnesia takes over America

Tuesday

Nov 6, 2012 at 8:47 AMNov 6, 2012 at 8:48 AM

By Ahsan Habib

Many people are feeling good about our economy. Fareed Zakaria, who was critical of the debt-fueled growth and advocated fundamental restructuring of the U.S. economy in Time magazine in 2010, suddenly forgot that and wrote a piece in The Washington Post last month claiming that the “economy is recovering well.” He added that, if Mitt Romney is elected, President Barack Obama’s hard work will produce a “Romney recovery.”

The New York Times also had an editorial last Wednesday praising the economic recovery under Obama. Many professional economists are playing the same music in various forums.

In my opinion, most of us are suffering from “Economnesia.” We, including prominent economists and leading journalists, seem to have forgotten what a good economy looks like. To me, the continued presence of the following factors indicates that we are not living in a healthy economy.

First, we have a persistent and growing federal budget deficit. Deficit supporters invoke Keynes to justify it. But the Keynesian approach does not recommend habitual deficit spending. There must be surplus years to eliminate the debt created by deficits. But since 1981, the U.S. economy did not see a federal budget surplus. The so-called “Clinton surplus” was created by counting certain obligatory payments as revenue. The national debt increased in each of the last 30 years, which means that the national economy was being managed by deficit in each year. Since 2009, the federal deficit has increased to an unprecedented $1.3 trillion annually.

Second, we depend on artificially lowered interest rates. Interest rates are an important factor in any economy, and markets should determine their proper value. When they are artificially pegged low it means we have bypassed the market to fix the economy.

Third, because our businesses are not responding to low interest rates, the Federal Reserve Bank has promised to keep it low for the next three years and hinted at more stimulative actions in the future.

Fourth, we have become addicted to continuous injections in the monetary supply. Sadly, after failing to create any visible impact with interest rate manipulations, the Federal Reserve resorted to the desperate measure of letting the money supply grow. There have been three rounds of monetary expansion, sugar-coated with the term “quantitative easing.” The process is still going on, and the Fed is buying more than $50 billion of bonds every month.

The U.S. monetary supply remained around $1.3 trillion during 2003-07. But then it started to grow rapidly and by this September it reached $2.4 trillion, an increase of about 80 percent! Potentially serious inflation is just waiting to engulf the economy.

Fifth, while the U.S. had a trade surplus during most of 1950s and ’60s, since 1974 we have never had a year of trade surplus and the trade deficit in 2011 was $560 billion.

Sixth, we should not forget that the economy is going through another textbook stimulus, the “tax cut,” initiated by Ronald Reagan and essentially continued until George W. Bush lowered it further. President Obama, as we all know, let it stay. Our tax structure is not in harmony with our spending commitments.

Finally, the managers of our economy, the political parties, have failed miserably to address any of the serious issues mentioned above. All they have to offer is makeshift solutions.

Each problem described above is unnatural and is not expected to prevail in a healthy economy. These are like artificial poles we use to temporarily shore up a structure which tilts after a storm. These supports may create an impression that the economy has weathered the storm and is doing all right. And because of Economnesia we are forgetting that we are living in a glass house.

On Oct. 29, CNBC analyst Liza Jansen reviewed a book written by Elliott and Atkinson titled “Going South: Why Britain Will Have a Third World Economy by 2014.” In that book, the authors argue that for the last several decades the UK economy has been run by “quick fixes after quick fixes” and is heading toward a fast decline despite GDP growth.

Not surprisingly, I see most of their analysis applies to the U.S. as well, although U.S. decline in a $15 trillion economy may take longer.

One factor that enables the U.S. economy to avoid the consequences of trade deficits, borrowing and monetary expansions is the attractive power of the dollar to international investors. As long as this trend persists we will be insulated from some negative effects that accompany reckless economic behavior.

Let me conclude by narrating a personal experience. Several years ago one of my living room chairs broke. A friend jumped to the occasion and fixed it and left proudly. We were happy for some time until we realized that the chair is usable only as long as it is supported by the wall. Once we removed it, it fell apart.

Each successive government in Washington is using the same trick to “fix” our economy.

Ahsan Habib is a professor and chair of the Economics Department at Adrian College.